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Lack of drilling leads to lease default for Furie

A Cook Inlet natural gas extractor that relied heavily on state tax credits — and which partially blamed undrilled wells over the past two years on the state’s lack of funding for those credits — is now in default of its state lease for its failures to drill.

In a default notice to Furie Operating Alaska on Dec. 26, 2017, Alaska Department of Natural Resources Commissioner Andrew Mack wrote that Furie’s operation of Cook Inlet’s largest state lease area — the 83,394-acre offshore Kitchen Lights Unit — “reflects a history of committing to drilling activities, but then delaying or changing those work commitments.”

“In short, Furie has failed to meet its drilling commitments going back to 2015,” Mack wrote. “It committed to drill two wells by November 30, 2015. Furie did not drill the wells. (DNR’s Division of Oil and Gas) approved a (plan of exploration) amendment to defer those drilling commitments to November 30, 2016. Furie did not drill the wells. Furie committed to drilling two wells again in 2016. It did not drill those wells, and again seeks to defer its commitment another year.”

DNR Deputy Commissioner Mark Wiggin said the default notice was a “fairly straightforward” response to Furie not accomplishing commitments made in the yearly plans of development that oil and gas lessees are required to submit to the state.

“We’re just reading the words they put on the page, and approving or disproving the (plan of development),” Wiggin said. “Once they commit to the drilling and they approve the PoD, by statute and regulation they need to perform. If they don’t, there are statutes and regulations that provide mechanisms, and we’re just following those.”

If Furie fails to finish an incomplete well it began in 2016 and to drill and test another a new well by the end of 2018, DNR may terminate Furie’s lease of the Kitchen Lights unit or contract the unit. Wiggin said his agency didn’t expect to use these options.

“We’re counting on the fact that they’re going to cure (the default), to do the work, and we look forward to them being successful,” Wiggin said.

Previous defaulting companies have mostly done so because of bankruptcy, Wiggin said. He didn’t know of another company that had defaulted for failing to accomplish its drilling plans.

Representatives of local utilities contracted to purchase Furie’s gas to burn for heat or electricity — Homer Electric Association, Chugach Electric Association, and the regional distributor ENSTAR — said their companies expected Furie would deliver on its contracts.

Furie had not responded to a request for interview by Friday evening.

Both Furie and the Kitchen Lights lease-holding company Cornucopia are held by the publicly traded Deutsche Oel &Gas, based in Luxembourg. Deutsche Oel &Gas chairman Kay Rieck — a German citizen living in Dubai, according to a 2015 lawsuit filing from Texas’ Third District Court of Appeals — is also the sole owner of another Cook Inlet oil and gas producer, Aurora Gas, which was forced into involuntary bankruptcy in May 2016.

Averting a shortage

Cook Inlet natural gas — which generates most of Southcentral Alaska’s heat and electricity — had its peak of production at 311 billion cubic feet per year in 1991. During the region’s most productive period, local utilities could rely on long-term gas supply contracts spanning 10–20 years, but as the major oil companies that developed the basin began to prefer more profitable prospects on the North Slope, a lack of investment in local drilling and exploration created potential gas shortages — with accompanying fears of power and heat outages — in the late 2000s.

Furie’s predecessor company Escopeta Oil and Gas arrived in Cook Inlet in the late 1990s with a wave of smaller independent companies. Furie installed Cook Inlet’s newest platform in summer 2015: the monopod Julius R, which can accommodate six wells. In its development plan that year, Furie committed to drill and evaluate two producing wells by November.

That fall the company also gained a utility customer: Homer Electric Association agreed in September 2015 to purchase between 4 billion and 6 billion cubic feet of Furie’s gas per year to feed the gas-fired generation plants that produce \80 percent of its electricity.

Though Furie’s first well was online and producing by October 2015, it told DNR that month that it wouldn’t meet the November deadline for the second.

“Market constraints have limited the volume of gas Furie needs to deliver in 2016, and probably until 2019,” a company representative wrote to DNR in Furie’s October 2015 development plan, in which it sucessfully petitioned to postpone the deadline. “As a result, Furie is unlikely to initiate production from more than one additional development well in 2016, and two additional development wells are unwarranted by the market.”

In February 2016, the regional gas distributor ENSTAR also contracted supply from Furie, agreeing to purchase 18.6 billion cubic feet of gas over three years. Furie’s contract with ENSTAR required it to “have at least three wells that can be used to produce the volumes of gas contemplated under the (gas supply agreement)” by Dec. 31, 2016. Furie would begin delivering gas — about 20 percent of ENSTAR’s supply — in April 1, 2018.

In its March 14, 2016 letter to the Regulatory Commission of Alaska — the state agency that approves public utility transactions — ENSTAR Director of Rates and Regulatory Affairs Daniel Dieckgraeff wrote that ENSTAR sought gas supply from Furie “with the goal of opening the door to a new producer and helping to foster competition, diversification of supply, and the growth of the Cook Inlet market.”

Tax credits

The Alaska Legislature also had this goal for its program of refundable tax credit incentives, which Furie relied on heavily to finance its work in Cook Inlet. Furie’s ownership company Cornucopia Oil and Gas took $39.8 million of the $72.6 million the state paid for tax credit obligations in calendar 2016, according to an April 2017 report from former Department of Revenue commissioner Randall Hoffbeck to legislators.

In 2016 Furie used the jack-up rig Randolph Yost to drill its second well and begin a third, but when Gov. Bill Walker vetoed payment of tax credits in June — cutting an appropriated $430 million payment to the statutory minimum of $30 million — it “essentially gutted Furie’s sourced budgeted funds,” company representatives would write in their 2018 development plan.

Furie notified ENSTAR in December 2016 that it would not have a third producing well by the end of the year, as required in its contract.

“ENSTAR worked extensively with Furie in January and February (2017) to discuss Furie’s plans and to allow a third-party contractor to review Furie’s well and reserves data,” Dieckgraff wrote in a Sept. 2017 letter to the RCA. “Following these meetings, ENSTAR agreed to extend the deadline for Furie to meet the three-well condition to July 31, 2017.”

During the 2017 drilling season, the legislature would appropriate $77 million for tax credit payments. Though the amount Furie cashed in that year is unknown — the Department of Revenue is scheduled to report calendar 2017 credit payments in April 2018 — the company “has a very substantial amount of tax credit certificates in the queue awaiting purchase by the state,” according to its 2018 plan of development.

“These certificates are a key component to funding further exploration and development activities in the (Kitchen Lights Unit) and were relied on by Furie when putting together its work program and budget,” the plan states.

Though Furie brought the Randolph Yost back to Cook Inlet in 2017 and kept it staffed for drilling from April to mid-August, the state budgets containing the credit appropriations did not pass until late summer — just before the tug boat that performed anchor-handling for the Randolph Yost left for a dry dock in Singapore, ending the company’s drilling season.

Meeting the contracts

“On July 25, 2017, in a meeting attended by Furie’s lenders, Furie informed ENSTAR that it would not meet the July 31, 2017 deadline. ENSTAR has once again engaged with Furie and its lenders to review its proposed plan to ensure it can provide reliable gas supply to ENSTAR’s customers,” Dieckgraeff wrote to the RCA in a Sept. 2017 proposal to modify ENSTAR’s contract with Furie. “After conducting this due diligence, ENSTAR has become convinced that its customers will be adequately protected and served under this contract as modified.”

As a result of Furie not meeting the contract conditions, ENSTAR will pay less for the gas it will start taking in April. Dieckgraeff in his letter to the RCA estimated the savings at between $9 million and $15 million over the course of the contract. Another condition of the ENSTAR-Furie contract allows ENSTAR to purchase replacement gas from a third party at Furie’s expense, if Furie cannot provide the required amount.

“While Furie has missed certain deadlines, it does have two producing wells, and ENSTAR is reasonably certain that the third well will be in production for the winter of 2018-2019,” Dieckgraeff wrote. According to a development schedule in ENSTAR’s amended Furie contract, Furie plans to bring the Randolph Yost back to Cook Inlet from April to May, and to have the third well producing gas by July.

HEA has been taking gas under its contract with Furie since April 2016, and in September 2017 extended the contract to the end of 2019. Another optional extension could continue it to 2020.

“HEA is not concerned about surety of supply since a provision in the Furie agreement gives HEA priority over all other Furie gas contracts,” wrote HEA Director of Member Relations Bruce Shelley in an email.

Like HEA’s, ENSTAR’s Furie contract also gives ENSTAR priority over later commitments. Chugach Electric Association signed its contract with Furie in March 2017, which will supply the utility cooperative with about 1.8 billion cubic feet of gas a year from April 2023 to March 2033.

“We understand the challenge of gas field development in the Cook Inlet, and we do not expect the DNR’s default letter to impact Chugach’s gas contract with Furie,” wrote Chugach spokesperson Julie Hasquet in an email.